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Medical monitoring benefits are not taxable, the Internal Revenue Service has held in a private letter ruling. The ruling came in response to a request from a team of lawyers at Wolf, Block, Schorr and Solis-Cohen in Philadelphia who are handling the administration of the massive settlement in the fen-phen diet drug litigation. Attorneys Andrew A. Chirls and Mark K. Kessler, who represent the American Home Products Settlement Trust, enlisted the help of Wolf Block tax partner Jay Goldberg when they found that the law was unsettled on the issue of whether medical monitoring benefits are taxable. The issue is a significant one in the diet drug case because many class members are receiving only medical monitoring benefits in the form of free echocardiograms to determine if they have suffered any damage to their heart valves as a result of taking the drugs. Chirls and Kessler needed to know if it was necessary to send a Form 1099 to such recipients. They hoped that the answer was no since a free echocardiogram valued at $800 could result in a tax bill of $300 and therefore wouldn’t be free at all. Recipients, they feared, might forgo the test if taking it would lead to a bill from Uncle Sam. Together with Goldberg, they urged the IRS to rule that such benefits are not taxable and that the AHP Settlement Trust therefore had no duty to withhold taxes or to report the payments. In their brief to the IRS, they argued that tort law in many states already holds that the need for medical monitoring is a compensable “injury.” “The question under tax law is not whether there has been an alleged injury, but rather, what kind of injury is incurred when a person is exposed to a dangerous substance that gives rise to the need for specialized medical screening,” they wrote. “The tax law has not dealt with this issue before, and a different tax analysis applies depending on whether the injury is characterized for tax purposes as personal or economic,” they wrote. In the brief, they urged the IRS to rule that the need for medical monitoring should be characterized as a personal physical injury and, therefore, that benefits paid in a medical monitoring class action are exempt from income taxes. But even if the IRS characterized it as an “economic injury,” they argued that it should still be tax-exempt since they cannot be considered “income.” “Regardless of how the medical claim is characterized for tax purposes, the economic fact is that the class members … are merely being restored to the economic position they would have been in had the diet drugs been safe,” they wrote. “These class members laid out their own money for medical screening and drugs, or in the case of class members whose echocardiograms were paid for by the [AHP Settlement Trust] directly to the service provider, money was laid out on their behalf.” As a result, they argued, the payments for such screenings cannot legally be considered “accession to wealth, clearly realized and over which they have complete dominion.” Now the IRS has issued a private letter ruling that grants all of the Settlement Trust’s requests. The letter states that refunds paid to class members for the costs of the drugs is not “gross income” and therefore not taxable. But that ruling was based on two assumptions — that the class member did not deduct the cost of the drug in a prior tax year, and that the refund did not exceed the original amount paid for the drugs. With those assumptions in mind, the IRS held that the Settlement Trust has no duty to report the refunds. The letter also said the trust need not report or withhold taxes from the payments to class members to reimburse them for the costs of obtaining medical monitoring services. But the ruling also closed with a proviso that strictly limits its use: “This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.”

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